The Goose that Laid the Golden Egg and Nobody Wants It

The European Central Bank (ECB) recently announced that it is back in the business of attempting to stimulate a moribund Euro economy with yet another dose of monetary steroids. Apparently, the Great Recession has not been put to bed over there.

As the central bank prints more money and buys more bonds, it is paying prices that exceed not only the return of principal when the bonds mature, but also all interest collected in the interim. That is the formula for negative interest rates: You pay more than what you get in return.

A bond purchaser under these terms has a known sure loss — that’s what negative interest rates mean. At some point in the accounting cycle, the bond purchaser’s losses become recognized on the balance sheet and fall to the bottom line. The price the ECB is paying for bonds is so steep that it translates to losses on the transaction, thus extinguishing the central bank’s own net worth or capital over time.

Now, as long as the central bank purchases bonds generally from commercial banks, it pays an amount in excess of what the bond will yield in both principle and interest — and surely more than what the bank paid for it in the first place.

The central bank thus subsidizes the commercial banks with the hope and expectation that these banks will turn around and make funding available to private borrowers under terms that do not require the full repayment of the loan amount. To further facilitate negative interest rate lending, the central bank lends directly to the commercial banks at negative rates, expecting them to pass on these negative interest rates in loans to their commercial borrowers.

For example, commercial banks might lend, say, $1,000 to a private borrower who would only need to repay some smaller amount, say $900 in total. By doing this, the ECB hopes private-sector borrowers will take that subsidized money and build plant and equipment that would generate output, jobs, income, and maybe even exports for the home economy.

The ECB has propped up these “deals” for private borrowers in the Euro market since 2014, and economic growth appeared to be picking up marginally by 2018. At that time, the central bank finally discontinued paying prices that resulted in negative interest rates. But alas, growth began to diminish again just months later, prompting the ECB early this year to resume its strategy of making money available by buying bonds on terms that translate into negative interest rates. It is now looking like central bank subsidies to private borrowers via the commercial banks has become a semi-permanent feature of the Euro economy.

What does that tell you? There has to be something in the calculus of business investment in the Eurozone such that even subsidized access to funds is insufficient to cover other problems of investing in real physical capital. Hence, this monetary policy is not ramping up investment spending enough to drive the economy. It is as if the central bank were a goose that laid a Golden Egg that private borrowers do not want or at least find unacceptable if it requires investing those funds as well as their own funds in the Euro economy.

This is a clear indication that there must be some supply-side barriers — such as regulation or costs or taxes — that deter the private sector from responding with investment spending when being paid to take the funds and investment them. You cannot fault the central bank for trying to be ultra-Keynesian by lending at not just low rates but negative rates to businesses via banks. However, at this point it’s clear that that the golden egg is not enough to overcome whatever barriers exist, and that is where the policy attention must shift if there is to be sustained private-sector recovery and growth.

To put it another way, the ultra-Keynesianism of demand-side monetary policy has reached its limit in Europe, and isn’t working. It is time to figure out why not, and fix it.

A country needs to pay attention to the environment and barriers thereto and hence the ability of a private entity to operate successfully. Indeed, there is a new competition-taking place among countries with India and China among the five most improved in this past year.

As matters stand, business is not accepting the gift of the golden egg of extreme monetary policy if the quid pro quo is investing their own funds and efforts trying to succeed at “do business” in the EU.